Death of an Expatriate

The American Jobs Creation Act of 2004 (AJCA) has made it more costly for former U.S. citizens and long-term residents (e.g., green-card holders for at least eight of the 15 years before termination of U.S. residency) to die in the U.S. The effective date of the new provisions is for acts of expatriation (including residency terminations) after June 3, 2004.

In addition to annual information reporting requirements, the AJCA requires an expatriate to notify either the Secretary of State or of Homeland Security and to submit an information statement under Sec. 6039G; otherwise, the act of expatriation is invalidated. Note: Residency terminations include electing dual-resident status as afforded under treaty benefits.

Overview

The AJCA revisions to the estate and gift tax rules as applicable to expatriates and long-term residents are as follows.

U.S. presence: First, under AJCA Section 804(c), amending Sec. 877(g)(1), a person is treated as a resident if present in the U.S. for more than 30 days in any calendar year during the 10-year period following expatriation. If death occurs in that same calendar year, the expatriate would be a U.S. resident for estate tax purposes. Thus, the effect is as if expatriation did not occur; all property, wherever situated (including foreign-situs assets), would be included in the gross estate. Likewise, all gratuitous transfers during such calendar year, regardless of where the property is situated, will be subject to gift tax.

Congress was concerned that individuals relinquishing citizenship or terminating residency still wanted “a piece of the pie”—i.e., did not want to fully sever ties with the U.S. and hoped to retain the benefits without taxation. Imposing full U.S. taxation for exceeding a minimal specific threshold of U.S. presence is intended to discourage this behavior. The presence threshold includes any day in the U.S., except for a limited stay while performing services as an employee. The employee must not be related to the employer.

Three tests: Second, pre-AJCA, certain dual residents could rebut the presumption of a principal purpose of tax avoidance by requesting an IRS ruling. The AJCA has eliminated the need for inquiry as to intent of tax avoidance. For a taxpayer who meets any of three Sec. 877(a)(2) tests discussed below, the expatriate rules will apply during the 10-year period following the act of expatriation. (There is a limited exception in Sec. 877(c) for certain dual residents and minors.) The three tests are as follows:

1. Average annual net income tax liability in excess of $124,000 (as adjusted for inflation) for the preceding five-year period;

2. Net worth at the date of expatriation of at least $2 million; or

3. Failure to comply with certification requirements.

The average income tax and net-worth tests have been retained, with a significant increase to the amount of required net worth (formerly $622,000, as adjusted for inflation). The third requirement was added to aid the IRS in enforcing the rules; annual reporting is now required.

By eliminating the ruling process, the new law brings more certainty to the expatriate regime. The major effect of the estate provisions is still the inclusion of the deemed U.S. value of stock in certain foreign corporations (see the definition, below, as pertaining to gift tax) in the estate of an expatriate dying within the 10-year period following expatriation.

Gift tax: For gift tax purposes, existing rules will cover intangible gifts, such as U.S. stock and securities, given by an expatriate during the 10-year tainted period. Under AJCA Section 804(d), gifts of certain foreign corporation stock will now be “caught in the web” as well. The provision offers symmetry with the estate tax rules referred to above. According to Sec. 2501(a)(5), the specific target is a foreign corporation in which the expatriate directly owns at least 10% of the voting power and more than 50% of the vote or value (applying attribution rules). Such a foreign corporation is equivalent to a controlled foreign corporation. The value of its stock subject to gift tax is determined by referring to the proportion of U.S.-situs assets (including U.S. stocks and securities) held by the foreign corporation, to total worldwide assets held.

Conclusion

The new law will force reassessment by individuals who are considering either renouncing U.S. citizenship or terminating U.S. residency solely for tax reasons. They must now sever ties with the U.S. more fully.

From Paul Dailey, CPA, New York, NY